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July 16, 2004

Commissioner Atkins Dissects Fraud Rationale of Registration Proposal

NEW YORK (HedgeWorld.com)--Fraud by hedge fund managers was front and center in the case made by Securities and Exchange Commission Chairman William Donaldson and two commissioners, Roel Campus and Harvey Goldschmid, for the proposed mandatory registration rule.

At the SEC open meeting today, the other two commissioners, Paul Atkins and Cynthia Glassman, strenuously criticized the proposal, voted against it and asked that their dissenting opinions be included in the release. Mr. Atkins quoted a 2003 SEC report that states there is no evidence hedge funds or their advisers engage disproportionately in fraudulent activity.

One number mentioned several times by advocates of the proposed rule was that there have been 46 enforcement actions by the SEC against hedge fund advisers in the past five years. "Will our proposed solution solve this problem?" asked Mr. Atkins, who proceeded to pull apart the oft-quoted statistic of fraud and to show that in most, if not all, cases mandatory registration could not have made a difference.

Of the 46, eight were registered investor advisors-- already being subject to SEC oversight did not prevent their fraud. In two of the cases, the fraud involved a principal of a registered broker-dealer or investment adviser. "We already had full regulatory oversight in these cases," Mr. Atkins said.

In another 20 cases, the funds were too small to be covered by the proposed rule; they all had assets of less than US$20 million, and many were well below that amount, so they would have been under the SEC radar.

In five of the cases, the fund should have been registered under the Investment Act of 1940 according to current rules, which would subject them to more strenuous regulation than the proposal.

Three cases were garden-variety fraud designed to swindle investors regardless of whether the vehicles were called hedge fund or something else. "Registration might have deterred them from using the words hedge fund, but would not have deterred the fraud," said Mr. Atkins.

Mandatory registration might have had an effect in only eight of the 46 cases, but according to him even these present challenges for proponents of the rule. "Most involved valuation problems that have been notoriously difficult for us to detect, even if the adviser is registered," he said.

He pointed out that only perfect timing by SEC examiners would have provided any benefit to investors and routine examinations are notoriously ineffective in ferreting out fraud when there is deliberate cover-up. He fears that registration could only create the false impression that hedge funds have the commission's seal of approval.

Advocates of the proposed rule naturally disagreed. They argued that registration would create a culture of compliance and deter abuse.